1 Area Kodiak Oil & Gas Investors Need to Watch Closely

It was a bad winter for the energy industry. Rough winter weather wrecked North Dakota focused Kodiak Oil & Gas' (NYSE: KOG) first-quarter forcing the company to reduce its full-year production guidance. However, that same bad weather didn't really bother fellow Bakken Shale producers like Halcon Resources (NYSE: HK) or Continental Resources (NYSE: CLR) as both actually reported results that exceeded expectations. In fact, while it seemed like most energy companies endured some sort of weather related hit this past quarter, few were as affected by the weather as Kodiak Oil & Gas. That's because the company spent too much of its time and energy in the quarter drilling on its less valuable acreage.

Drilling down into the area of concernKodiak Oil & Gas noted that it drilled a number of wells in its Wildrose area to hold that acreage by production. This is where the weather had the biggest impact as the company. According to CEO Lynn Peterson on the company's conference call,

We ended the New Year with the intent to drill some of our short-term leases in our Wildrose area in Northern Williams County in order to hold all of our acreage by production.

We felt that we could drill and complete a total of five wells early in the year and then move into our core areas and start to ramp up our production. Unfortunately, with the weather conditions we didn't get to our core areas until March and the result in production gains fell principally into the second quarter.

The production from the few Wildrose wells was further delayed as this is an area of thinner source rock with less reservoir pressure that requires us to put these wells on artificial lift almost immediately. With the weather conditions we were unable to get in our workover rigs onto locations quickly and set the pumping units.

As the following slide notes, Wildrose is really an outlier within the company's portfolio.

The position is well to the north of the company's core areas of Polar, Koala, Ursid and Smokey. However, it does represent more than 10% of the company's total acreage position as well as 100 of its 1,300 future well locations. For perspective, that's basically a year's worth of growth at the company's current pace of 100 wells a year. Because of this, its an area that investors need to watch as it could continue to be a drag on the company's results in the future.

No where else to go Another issue for Kodiak Oil & Gas is that its only focus is on the Bakken while peers like Continental Resources and Halcon Resources have the Mid-Continent and Eagle Ford Shale, respectively, to drive future growth. This laser focus on the Bakken Shale appears to be putting Kodiak Oil & Gas at a disadvantage as it has no where else to drill when the weather turns bad whereas Continental Resources and Halcon Resources can plan to drill more wells in areas less affected by the weather when it becomes a factor in North Dakota.

This one-two punch of drilling less valuable acreage in the dead of winter is why Kodiak Oil & Gas saw its production slip 6% over last quarter. However, on the other hand we saw the much larger Continental Resources actually grow its production in the Bakken by 4% over the previous quarter while it used its position in Oklahoma to drive 24% production growth over last quarter. That led to strong 6% growth in overall production, despite the fact the company had trouble getting Bakken wells complete due to the weather. The big difference here is that Continental Resources didn't spend the winter drilling on its less valuable acreage, it drilled wells that it knew would produce results. The same can be said of Halcon Resources, which saw triple-digit year-over-year growth in the Eagle Ford. This is why these companies are on pace to hitfull-year production guidance while Kodiak Oil & Gas is not.

Investor takeawayKodiak Oil & Gas thought it could easily drill the weaker parts of its acreage in order to hold those leases. It's a move that appeared to have backfire as those wells really didn't help the company in the quarter. Obviously, in hindsight the company would have been better off if it planned to drill more of those wells during the spring and summer months so that it wouldn't start the year off on such a poor note. Bottom line here, investors need to keep a close eye on Wildrose as it appears to be the wild card within the company's portfolio.

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I feel this was good management foresight on the part of the company. Nothing was said in the article as to when the primary terms of the leases expired. If there were early expiration dates, then it became a case of drill or lose the leases.

If they lose leases in that area, whether the area is somewhat weaker than some of the other areas they own, it would still cost them an arm and a leg to regain those properties..